Jordan Fuchs, Alexander Haubold, Colin Skaf
Isabella Norcini, Elonia McHenry, and Shelby Hinds

I. Defining Growth - causes
III. Expenditures and Income Approach
IV. Nominal vs. Real GDP
V. Shortcomings of GDP
VI. Business Cycle, Unemployment, Inflation

Key Terms:
Modern Economic Growth: output per person and standard of living increases


Real GDP: Hours of work x labor productivity
  • Labor productivity: Real output per hour of work
Nominal GDP: GDP measured in terms of the price level of the time of measurement (not adjusted for inflation)
Economies of scale: Reductions in the average total cost of producing a product as the firm expands the size of plant (its output) in the long run -> economies of mass production
Recession: Period of declining real GDP accompanied by lower real income, and higher unemployment
Expenditures Approach: GDP as the sum of all money spent in buying it (output approach)
GDP = C + Ig + G + Xn
C = Personal Consumption Expenditures -> Expenditures by households on durable and non-durable goods, and services
Ig = Gross Private Domestic Investment -> Final purchases of machinery, equipment, and tools by businesses enterprises + all new construction and changes in inventory
G = Government Purchases
Xn = Net exports = Exports (X) - Imports (M)
Income Approach: GDP in terms of income created from producing it (earning /allocations approach)
GDP = Wages + Rents + Interest + Profits + Statistical Adjustments (other stuff)
Types of Unemployment:
  • Frictional Unemployment: between jobs/ seasonal/ possibly switching career
  • Structural Unemployment: demand for skills declines/ geographically obsolete
  • Cyclical Unemployment: jobs lost by business cycle
Natural Rate of Unemployment: Frictional + Structural Unemployment
  • When economy is at potential output
  • ~ 4-6%
GDP Gap: Actual GDP- Potential GDP
  • Okun's Law: For every 1% point the actual unemployment rate exceeds the natural rate, a negative GDP gap of 2% occurs
Demand-pull inflation: Increase in demand causes inflation
Nominal GDP increases much quicker than real GDP
"Too much spending chasing too few goods"
Cost- push inflation (Supply-side): Output and employment decline while general price level rises
Stagflation: inflation and unemployment
Aggregate Supply shifts left causing real GDP to decrease and price to increase
Hyper-inflation: extraordinarily rapid inflation -> has devastating impacts
Ex: money becomes worthless, people invest in gold
Price Index: measures inflation and deflation
Eq: (price of market basket in year A)/(price of market basket in base year) x 100
Ex: If the price index is 120, then price level was 20% higher than the previous year -> inflation
Eq: (nominal GDP)/(real GDP) x 100

Components of GDP

Source: MBF Text Book
Divergence of Growth

Source: MBF Text book


1. Stagflation occurs when:
a) Price level and output both fall
b) Price level rises and output falls
c) Price level falls and output rises
d) Price level and output both rise

2. A worker who sorts potatoes seeking employment after the invention of a potato sorter is an example of:
a) Structural unemployment
b) Frictional unemployment
c) Cyclical unemployment
d) Natural unemployment

3. An economy is at the full employment rate when...
a) no frictional unemployment
b) No structural unemployment
c) No cyclical unemployment
d) No frictional, structural, or cyclical unemployment
e) The natural rate of unemployment is 0

4. Which of these always occurs in a recession?
a) Unemployment decreases
b) Real GDP declines
c) GDP remains constant
d) Nominal GDP declines

5. According to Okuns Law, when the actual unemployment rate is 3% greater than the NRU, there is...
a) Negative GDP gap of 6%
b) Positive GDP gap of 6%
c) Negative GDP gap of 3%
d) Positive GDP gap of 3%

6. Unemployment data underestimates the amount of unemployed workers because:
a) Part-time workers are not included in the labor force
b) It only includes frictional and structural unemployment
c) It does not include those unemployed in underground economies
d) Discouraged workers are not included in the labor force

7. Which of the following is not an institutional structure that promotes growth?
a) Strong property rights
b) Patents and copy rights
c) Tariffs on foreign trade
d) Competitive market system

8. An example of a shortcoming of GDP is...
a) Leisure enjoyed by citizens is not measured
b) Goods and services produced but are not bought
c) The amount of work done by homemaker is overstated
d) It measures negative externalities

9. What is the GDP of an economy that has... (Measured in billions) Consumer expenditures are $3,001, Government purchases $9,909, Gross investments $4,205, Net exports $44, Net imports $59.
a) $17,317
b) $17,258
c) $17,199
d) $17,001

10. GDP excludes all of the following except:
a) Second-hand sales
b) Goods sold from inventories
c) Financial transactions
d) Final goods

11) If an economy experienced inflation beyond the expected rate which groups would be affected?
II. Borrowers
III. Fixed Income Recipients
A) I only
B) II only
C) III only
D) I and III
E) II and III

12) Everyone of these are effects of Cost Push Inflation EXCEPT:
A) Rising Prices
B) Lower Unemployment
C) Increased Production
D) Stagflation

13) If an economy wants to double GDP in 5 years what is the percentage of annual growth that economy needs to sustain?
A) 5 %
B) 10 %
C) 7 %
D) 14%

14) If Bob’s Real income changes by 6 percent from one year to the next and the rate of inflation was 2 percent, by how much did Bob’s income change without adjusting for inflation?
A) 2%
B) 3%
C) 8%

15) Which would be true if a country's GDP exceeds its normal GDP at full employment?
A) Below equilibrium unemployment
B) Negative GDP gap
C) Lower interest rates
D) Positive GDP gap
16) If the price of 3 oranges in 2008 was $15, and in 2009, 2 oranges cost $15, what would be the rate of inflation?
A) 20 %
B) 50 %
C) 75 %
D) 150 %

17) Bob is angry because he realized that his income of 20,000 in 2008 is now worth only 15,000, what would the price index have to be for Bob to experience such devaluation?
A) 1.8 %
B) 1.4%
C) 1.3 %
D) 2 %

18) If farmer Bill buys 5 tractors in 2009 and in the same year 2 of those tractors breakdown and 3 more are bought to replace them, Farmer Bill has a:
A) Gross investment of 6 tractors
B) Gross investment of 2 tractors
C) Net investment of 8 tractors
D) Net investment of 6 tractors

19) If Roger’s Dodger makes 30, 2009 models and sells 25 of them in 2009, and then in 2010 sells 3 more 2009 models and produces 10 more 2010 models, how many cars are counted in GDP for 2010?
A) 13 cars
B) 3 cars
C) 10 cars
D) 38 cars

20) If through monetary policy the interest rate would decreases which component of GDP would rise?
A) Net Exports
B) Consumption
C) Investment
D) Government Spending

(Multiple choice questions 11-20 by Alex Haubold)

Answers: 1) b 2) a 3) c 4) b 5)a 6)d 7) c 8) a 9) b 10) d 11) D 12) D 13) D 14) C 15) D 16) B 17) C 18) D 19) C 20) C

Recent advancements in technology have made it possible to produce more of product X.
A) Explain how technology could influence the costs of this firm and make it possible to produce more of product X.
B) Sketch the change in aggregate demand and aggregate supply assuming that the economy was operating at equilibrium before the technology was invented. Also explain what would happen to price and quantity produced.
C) How would unemployment be affected?
D) How would the Production Possibilities Curve change? Explain.

A) Advancements in technology would reduce costs for Bellagio's Chocolates by increasing their productivity. With the added technology they can now produce more units for the same price.
B) Aggregate Demand would remain unchanged but Aggregate Supply would shift right to comply with the increase in production. Price would go down (only if prices were flexible downward, if they were inflexible they would remain at the same equilibrium level as before) and Q would increase.
C) There would be a reduction in unemployment because of the increase in Q (GDP)
D) The production possibilities Curve would remain unchanged because the cure assumes that Employment and Technology remain unchanged.
(Short answer by Alex Haubold)

The Orchid Industry:
a) The cost of fertilizer increases due to a shortage in one of its main chemical ingredients, what will happen to the per unit production costs?
b) Show this change on the Aggregate Supply and Aggregate Demand curves
c) What does this change result in?
d) What happens to the output and price level?
e) If a similar situation occurs throughout the entire U.S.' economy, causing unemployment to rise 2% above the natural rate, how would GDP be affected? Indicate the law used.

a) It increases because the input costs increase
c) Cost-push inflation
d) Output decreases and price level increases
e) GDP decreases by 4% according to Okuns' Law

News Article:
The NIA (National Inflation Association) is worried about a possible case of hyperinflation in our future, due to a healthcare bill and rising national debt. Medicare and the Iraq War have cost the U.S. dramatically more than expected. In order to compensate for these costs, the U.S. may have to issue more currency. The increase in the supply of money could lead to high inflation rates. However, The White House expects the Fed to maintain low interest rates. If the interest rates are kept below the rate of inflation, hyperinflation will ensue.

(Isabella, Elonia, and Shelby)

Shortcomings of GDP

Non-Market Transactions
GDP only factors in transactions that occur in the market place. If there is no producer / consumer exchange within the market, the product or service is not counted in GDP. Example: if someone repairs their own car or works on their own house maintenance, the services are not counted as part of GDP.

Non-Economic Sources of Wellbeing
Because GDP can only measure market place transactions, it cannot account for societal benefits or increases in a household’s “happiness”. Some changes can make society better without increasing GDP. Example: Reduced crime and drug / alcohol abuse will not increase GDP, but it will benefit society.

As a result of shorter working hours and more leave days, workers have more time off to relax and spent their time out of the work place. This time off has been shown to improve productivity and reduce stress, but the leisure itself is not able to be counted in GDP.

Per Capita Output
Per Capita output can effectively measure economic prosperity in relation to the individual, while GDP calculates the economic prosperity of the nation. The GDP may be deceptive, because GDP does not necessarily raise at the same rate as the per capita output. Example: GDP rises 4% and per capita output rises 2% in one year. The nation’s GDP is increasing, but living conditions and household standards have relatively decreased.

Improved Product Quality
GDP takes quantitative measurements of the market, but it does not account for increased or decreased quality. As technology improves and makes components cheaper, products may cost less but be more effective. Example: a more advanced computer is developed, but the parts of the computer are able to be manufactured for less, so quality increased with cost decreasing

Underground Economy / Black Market
The black market is a market for illegal activities like gambling, robbery, prostitution, which are not factored into GDP. The people selling these products or services hide their income from the government to avoid prosecution. The underground economy can also encompass legal transactions which people decide not to report to the government. Example: a child mowing a lawn might not report his earnings to the government, or people trading services might not report the transaction.

Environmental Factors
An increase in production will increase GDP, but it usually will negatively affect the environment. Factories can dump chemicals and trash which can negatively affect society and the environment, GDP does not account for negative effects on society or the environment. However, when money is spent on services to clean the pollution, the cost is added to GDP. So the negative effects from increased production not only damage the environment, but increase GDP by spending money to fix them.
(Jordan Fuchs, Shortcomings of GDP)

Real World Example

In the first quarter of 2010, real GDP increased by 3.2 percent, while the real GDP increased by 5.6 percent the previous quarter. According to the BEA (Bureau of Economic Analysis), the increase in real GDP is a result of "positive contributions from personal consumption expenditures, private inventory investment, exports, and nonresidential fixed investment" (Gross Domestic Product: Fist Quarter 2010 (Advance Estimate)) although these increases were weakened by decreases in local government and state government spending.

We know that GDP growth can be measured by the formula: GDP = C + Ig + G + Xn. "C" (Personal Consumption Expenditures) increased, because households increased spending on goods and services. "Ig" (Gross Private Domestic Investment) increased according to the article because of the private inventory investment, which is the purchases of machinery, equipment, tools, construction, and changes in inventory. "G" (Government Purchases) decreased because local governments and state governments spent less money than in previous quarters. The "Xn" (Net Exports, Exports - Imports) increased because exports were higher than imports.
(Jordan Fuchs and Colin Skaf, Real World Example)

Even though the United States is the only industrialized nation that does not have guaranteed healthcare for all of it's citizens, it still spends a higher percentage of it's Gross Domestic Product on healthcare than any other nation. It also spends much more per person than any other countries. Since 1980, the amount of money spent as a percentage of G.D.P. has risen by seven percentage points. This article was written in 2009, before the Obama healthcare package, which undoubtedly shows the United States as spending a much higher percent of it's G.D.P. on healthcare than other countries.

(Colin Skaf, Jordan Fuchs)